It’s been an interesting Friday on the Chinese stock markets.

After a bit of excitment early in the morning, the CSI300 index and the Shanghai Composite Index were in positive territory. Small stocks, as measured by the ChiNext small cap growth board jumped more than 1%.

It wasn’t quite so sanguine earlier. The Shanghai Composite plunged more than 4% in early trading. Combined with its nearly 7% slide on Thursday, the Shanghai two-day drop exceeded 11%, breaking the 10% line considered a technical correction by traders. However, it didn’t stay there for long and by the afternoon it was up a little.

So was that it? Was that the official correction, or just a head fake?

“The correction is not yet over,” David Dai, Shanghai-based investment director at Nanhai Fund Management, told Reuters. “Yesterday’s slump was too rapid, so many investors didn’t have time to flee. Many are still seeking exit. The market has risen too much, and too fast, so the confluence of bad news is causing panic selling.”

Well, let’s examine the cause of yesterday’s move. A number of big name brokerages tightened their margin limits and the central bank drained an unspecified amount of liquidity from the interbank market through targeted bond repurchase agreements.

Analysts also cited a move by a central government asset management holding company Central Huijin to unload holdings in major state-owned banks.

Asia Unhedged can’t see why tightening margin requirements is a bad thing. But loweing the amount of stocks bought on credit, this removes a significant amount of pure speculation and quite a bit of air out of the “bubble.”  The last time the markets tightened margins was the beginning of the huge rally that ended on Thursday.

Xiao Shijun, analyst at Guodu Securities in Beijing told Reuters that Central Huijin’s move can be viewed as a signal the government “attempts to cool the recent overheated stock market as they are always eager for a steady, rather than, crazy bull.

“I expect to see more volatility in the short term. The correction is probable to last for a while until the mid-June when the funds locked up for this round of IPOs unfreeze,” he said.

Asia Unhedged expects more volatility as well. We agree with Dai that the correction is probably not over. Many investors are first-time investors and haven’t really experienced such a drop. They will have the weekend to digest the news and will probably sell in the next week or two. But if you’ve got the cash, get it ready. This baby is eventually going higher.

Leave a comment